Session 6 Market Integration

Hi, I was calculating the concept checkers for reading 23-schwesers book 2 page 107. I am little confused about the integration % and the returns-which one should be which ? In the example, market A has 80 % integration, but the weighted return calculation is other way around? Can someone clarify this ?

g - global market SR - sharp ratio RPM (integrated) = (std(m) * corr(m,g) / std(g)) * SR(g) RPM (non-integrated) = (std(m) * 1 / std(g)) * SR(g) integation is X RPM (integrated) * X + RPM (non-integrated) * 1-X = RPM total

Sweet another formula I don’t think I have ever seen! Is that in Schweser?

yes, it is there

Hi comp_sci_kid, My confusion is which should be x and multiplied by what? When market is 80 % integrated, that 80 % goes with what ? If you look at the problem, you will see. Thanks

80 % integration, X should be 80

csk, not sure if I understood your formula well. the correct formula is - RiskPremimum = Standard Deviation * Correlation * (Risk Premimum/Standard Deviation of the market)

  1. Estimate the risk premium if the markets are fully integrated (std(m)*corr(m,g)*SR(g))+LP 2. Estimate the risk premium if the markets are segmented (st(m)*SR(g))+LP 3. Calculate the weighted average of 1 and 2; that’s where your 80% is needed (80%*(1)+20%*(2). LP is the liquidity premium, if needed. By the way, as SR(g)=(r(g)-r(f))/sd(g), I think that sd(g) is not needed in comp_sci_kid’s formulas.

LP can be both in 1 and 2? thx

I think so. If something is illiquid, it is illiquid whether markets are integrated or segmented, so I would add the liquidity premium to both (which means that you could also do (1) and (2) and only reflect the liquidity premium in (3)).

In the examples that I have seen LP (when given) is the same for both markets (i.e. it’s just one liquidity premium number given). Thus, you can add it at the end, after calculating weighted avg of (1) and (2).